Bernanke Speaks: What to Expect From Fed Chairman

Federal Reserve Chairman Ben Bernanke gives an important speech at the Federal Reserve Bank of Boston Friday morning on monetary policy in a low-inflation environment — important because it comes just a few weeks before the Fed’s next policy meeting and because the time is ripe for him to lay out his thinking on the Fed’s next steps more clearly. Here’s our best guess about some of the issues that we think are on his mind:

—Quantitative Easing: Even though most investors believe the Fed is prepared to begin a new round of quantitative easing at its Nov. 2 & 3 meeting (i.e. purchases of long-term Treasury bonds), don’t expect Mr. Bernanke to just come right out and say it. The Federal Open Market Committee hasn’t made a decision yet and he won’t want to appear to the five other Fed board governors and twelve regional bank presidents on the committee to have pre-judged their two-day meeting. Mr. Bernanke wants to be seen inside the Fed and outside as building a consensus, not stepping on others’ toes. Still, it would be a very big surprise if the Fed chairman said anything to dissuade the public of the view that a new round of securities purchases by the Fed is likely.

—The Fed’s Framework: It’s become increasingly clear that Fed officials are trying to lay out a broader framework for how they’re thinking about the economy and how they will respond to economic developments in the months ahead. It would make great sense for Mr. Bernanke to use this opportunity to explain this framework in more detail. (We’re using the Fed’s terminology here. Minutes of its September meeting included this important line: “As a general matter, participants felt that any needed policy accommodation would be most effective if enacted within a framework that was clearly communicated to the public.”)

Central to the framework, it appears, is the delicate idea of “reflation.” The Fed wants to get the inflation rate back near its 2% goal, from the current rate in the 1% to 1.5% range. Officials don’t want the price level to fall for fear they could end up stuck in deflation, as Japan did. Moreover, even if the U.S. avoids deflation, as it so far has done, many officials would be unhappy if the inflation rate fell any further. Lower inflation pushes up real interest rates. (Real interest rate = nominal interest rate minus inflation). If anything, many Fed officials, though not all, believe real interest rates should be falling to support economic growth. So all signals point to a Fed looking for a little more inflation.

As an academic, Mr. Bernanke argued strongly for inflation targets and urged the Bank of Japan to more forcefully demonstrate that it was prepared to generate a little inflation as it emerged from its economic slump. The trick for Mr. Bernanke is getting inflation a little higher but not a lot. (It also would be nice if the Fed could ensure it will get inflation in the right places — like wages — and not in places that would hurt the U.S., like oil prices. But it can’t ensure that.) Mr. Bernanke has already said he doesn’t support a higher inflation goal of 3% or 4%. He’s probably sympathetic to a “price level” target which would allow the Fed to overshoot on inflation for a little while but not permanently. But neither he nor his colleagues are likely to be ready to go there yet. The economy isn’t weak enough to justify it. So, for now at least, he is probably left with a commitment to the 2% goal and the suggestion that he will keep pushing on policy levers like quantitative easing until he’s sure he’ll get there.

—Tactics: How will quantitative easing work? He might touch on this. Again, he won’t want to get in front of the FOMC on this question and pre-judge the committee’s discussions. But he could decide to lay out his thinking on the options — a small scale approach of a few hundred billion over a few months that might be continued if the recovery doesn’t pick up compared with a larger “shock and awe”-type approach used in 2009.

—Fiscal Policy: Fed officials sure would like to see Congress and President Obama develop a credible plan for reducing the budget deficit in the long-run and, at the same time, put more fiscal stimulus into the economy in the short-run. Mr. Bernanke has been deferential to Congress and the White House on these issues. But now that he’s being forced to step to the plate to support growth, he might be expected to speak out more forcefully in the months ahead on what he thinks the nation’s fiscal policy makers should do. It’s worth remembering that as an academic, he called for fiscal policy makers and monetary policy makers to work closely on solutions. Here is one recent example of him speaking out more forcefully on fiscal policy.